By Index Funds Staff

With an eye toward the possibility of a commodities-based ETF, Standard & Poor's announced the introduction of the S&P Commodities Index (SPCI). The new index will use a geometric method of calculation, and joins the widely followed Commodities Research Bureau (CRB), Goldman Sachs, and Dow Jones-AIG commodities indexes. Contiguous with the SPCI launch, the New York Board of Trade (NYBOT) announced the launch this fall of futures and options that will be based on the index.

S&P feels it can tap into a significant retail market that currently does not have easy access to commodities. "I really believe that this could be a major new asset class which thus far has been inaccessible to the public," said Bob Shakotko, managing director of index services at S&P.

The obvious obstacle for an exchange-traded fund (ETF) based on a commodities index is the problem of using futures contracts as the basis for the fund. Interestingly, Lee Kranefuss of Barclays Global Investors, manager of the iShares, commented in the S&P announcement - a hint that S&P is already working with BGI on possible development of an ETF.

"We think there's significant demand for instruments other than equity index-linked ETFs, and commodities and fixed-income funds are certainly among them," said Kranefuss.

Shakotko sees commodities as a legitimate asset class, akin to real estate in its lack of correlation to indexes. Traditionally, commodities have also been seen as a strong hedge against inflation. If commodities were ever to become widely used by the retail market for even a small - say 5% - portion of portfolios, the level of new assets could be significant.

S&P opted to use a geometric calculation methodology for the index in a bid to keep the index from tilting heavily to a single commodity, as was the case for the Goldman Sachs index, which at one point reached a weighting of nearly 70% in energy. An arithmetic unit is a basket where the physical units stay the same, while the weighting of the index changes with price. A geometric index, on the other hand, starts out with the proposition that each component will remain a certain proportion of the index value.

For instance, says Shakotko, "An arithmetic basket of meat might be 5 pounds of beef, 2 pounds of pork, 1 pound of lamb, and 6 pounds of chicken. With a geometric basket of meat, you might spend your meat budget in the following proportions: 30% on beef, 20% on pork, 10% on lamb, and 40% on chicken."

Thus, when the value of a commodity in the geometric index exceeds its maximum, the index sheds some of the high-priced commodity and buys some of the lower-priced commodity. It is, in other words, a reversion to the mean metric. The net effect is to level price volatility, though potentially at the expense of some upside.

"Geometric indices offer lower volatility and more reasonable assumptions in terms of handling price spikes," said Shakotko.

More Admiral Shares

The Vanguard Group launched Admiral Shares for six more funds yesterday: European Stock Index (VEURX), Pacific Stock Index (VPACX), International Growth (VWIGX), U.S. Growth (VWUSX), Equity Income (VEIPX), and Asset Allocation (VAAPX).

Admiral Shares undercut the expense ratio for investor shares, and are designed to reward large and long-standing accounts. Vanguard chairman and CEO John Brennan previously said that large and loyal shareholders create tremendous cost savings for all shareholders in a fund, and should therefore receive the benefits of the cost efficiency they generate.

08/14/2001